Robo-Advisors: A Closer Look

Investing

Robo-Advisors: A Closer Look

The rise of robo-advisors is disrupting the wealth management industry. Here we explore what robo-advisors have to offer, and see how they stack up against their human counterparts.

Published on 19 October 2017

Love them or hate them – and investors seem equally divided – robo-advisors are on the rise. And with over 100 robo-advisory services scattered around the globe with around US$20 billion of assets under management (AUM), it’s no surprise that major investment companies like Charles Schwab, Vanguard, and Betterment are taking this innovation quite seriously.

In July of 2016, Betterment’s robo-advisor AUM surpassed the US$5 billion mark, the first of the firms offering robo-advisor services to do so. Charles Schwab followed suit some months later.

It would seem that this trend is likely to continue, largely due to the fact that the wealth management industry has an increasingly tech savvy investor base, who are looking for lower costs and new and more efficient tools to help manage their investments.

As with any new technology, there are pros and cons to robo-advisors. Not having to deal with another human on the line has it attractive qualities, but also its disadvantages.

Here we take a closer look at robo-advisors and the services they provide.

What are robo-advisors?

In essence, a robo-advisor is a computer, a number of them actually, that uses automated, algorithm-driven processes to generate investment advice and manage your portfolio. This is done with minimal human intervention, which tends to take the emotion out of the equation when it comes to investing and managing your money.

No two robo-advisors are alike, and your investment strategy and asset allocation are largely driven by how you answer the questions when you sign up to invest. The questions, no matter whom you invest with, are relatively straightforward (and are typically multiple choice, or fill in the blank-type questions) that are designed to help determine your time horizon and risk tolerance. A computer programme then analyses your answers and applies quite complex diversified investing theories and automated investing tools. This process all takes place almost instantaneously, and within seconds out comes an investment portfolio designed specifically for you.

Portfolios with assets in multiple investments are common with robo-advisors, and can include diverse asset classes such as bonds, commodities, futures, stocks, foreign exchange, and real estate, but typically they are largely ETF-based portfolios.

Robo-advisors have actually been around since 2008, but really only took off in 2013 when some of the larger investment companies started to take them more seriously. The mathematical algorithms used to profile each individual investor are quite complex, and interestingly also take into account not only your risk tolerance and time horizon, but your age, your gender, and even your geographic location.

How do they work?

Investing ultimately comes down to your age (what cycle of life you are at investment wise), your time horizon, and your risk threshold. Interestingly, how much you actually have to invest is not the most important factor in devising an investing strategy.

Keep in mind that all of the robo-investment firms use different algorithms, which are manufactured based on the customers that they think they can attract, or already have, and algorithms that will add the most value to your account. Some, for instance, guide you to more stock heavy portfolios, while others take into account your future investment potential.

The attractiveness of robo-investing is that you don’t need large amounts of money to start, and many robo-investment companies will open an account for you with as little as US$500. Betterment actually has no minimum opening amount, although you will need at least US$10 to cover the electronic transfer fees from your own bank.

And if you are a millennial and just starting out and looking to build your wealth portfolio, then robo-investing could be a perfect avenue for you. In most cases there is instant gratification, not a lot to think about, and non-existent fees for the first year. All very attractive qualities particularly for the first time investor, and the investor with not a lot of cash to invest.

Indeed, by lowering the fees and the minimum investment amounts, robo-advisors have been able to capture a significant chunk of the mass affluent client segment. However, robo-advisors often miss out on the larger fish, and have had a hard time appealing to high net worth investors.

Robo vs. human

There is absolutely a market for robo-investing, and the billions of dollars that have poured into the industry in the last few years will attest to this. But is it better than dealing with a human wealth manager, is it the shiny new future of investing, or is there a middle ground?

There are no face-to-face meetings with robo-investors, and if you want to see a person across a desk in front of you then robo-investing isn’t for you. This is the case with many older first time investors and retirees with large sums of money to invest, who are steering clear of robo-advisor systems and services.

They actually like the idea of robo-investing, and can see its merits, but are perhaps afraid of the new fangled technology. They also usually have larger amounts to invest and like the idea of having a wealth advisor they can sit down with, someone who can guide them, and someone who can answer the plethora of questions that they have.

Ultimately customers want to know that they are cared for, and that they are not just giving their hard-earned savings to a machine that doesn’t actually know them or interact with them.

In practice it’s exactly what happened to many high street banks a few years ago. Banks in Europe and North America (not in Asia) decided to cut drastically the number people serving customers, to add more ATMs, and to limit customer contact to an absolute minimum. In theory this was a good idea as there were massive bottom line savings to be had, but in practice their customers hated the innovation and lack of human interaction, and moved away in droves.

Seeing a similar issue with robo-advisors, Charles Schwab, Betterment, and Vanguard and other firms in the wealth management industry recently came up with a solution: hybrid robo-advisors.

This neat service combines all of the benefits of automated investment management technology with the addition of human advisors at your call, if and when you need them. The fees are a little higher than normal robo-investing, and the minimum amount that you are asked to invest is also higher, but the hybrid robo-advisor model is proving to be popular.

With this hybrid model, you will be able to enjoy the benefits of an automated, customised investment portfolio that is designed by a robo-advisor to provide the greatest returns with the least amount of risk, but you also have unlimited access to human advisors and the ability to contact them if and when you need to.

All three firms that have adopted this hybrid approach are quickly adding clients, and acknowledge that there is indeed a need and demand for both human and robo-advisors in the market. Interestingly, many of the smaller robo advisor firms have taken note and are changing accordingly.

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